Why we use a cash budget

January 16, 2012

We use a cash budget to control our expenses; this is why we use a cash budget.

It was a cold and sunny day in November, so I wore my dark hooded sweatshirt and jeans.  The bill of my hat rested over my sunglasses, and I pulled open the bank's front door - anticipating the feeling of doing something I'd never done before.  I walked in and demanded twelve $100 bills.  If they didn't give them to me… well, we wouldn't have our cash for the month!

I started using the cash budget when I paid off my debt in 2007, and my wife used it since we married in 2009.  It's an important part of the Dave Ramsey plan to pay off debt, and it's what finally helped me take control of my money.

One big argument against using a cash budget is people will spend all of the cash in their pocket.  Trust me, I used to be the same way.  Before I was on the cash budget, anytime I had cash it would quickly disappear.  My spending was out of control, and I wasn't able to save money.

The key to controlling your cash is to pull out enough for the month and not spending anymore if you run out.  There were more than a couple of times I had too much month at the end of my money (Dave Ramsey saying), and I had to stop spending. 

Need more proof it works?  Check out this feedback from a great YLTL reader (Jojie),

"I have had a budget created and tried to follow (for a number of years..yes years!) but never worked out. Your tracking plans made it all happen for me (and also the envelop system). These were the key for me with getting my finance getting sorted and it's WORKING!"

If you need to take control of your money, the cash budget might be right for you.

How do we know how much cash to take out?

As I've outlined in the OWN IT plan, the first thing I did was complete a current assessment to figure out if I had any money.  Next, I retroactively tracked my expenses for the previous year by reviewing online statements from my credit and debit cards.  This gave me an idea of where my money was going and from there I set my budget.

You won't get it right the first time, and you'll probably need to adjust it quite a few times.  The important part is sticking to it.

Next, go the bank and pull out the amount of cash you need.  Dave Ramsey calls it the envelope system because you put your allocated amount of cash into a separate bank envelope for each category.  You don't need to carry all of the envelopes around with you, but you do need to track which category you've taken the money from.

Your categories are the major spending areas in your life.  Most people will have an envelope for food (grocery store, goods, etc), entertainment (eating out, bars, kid's fun, etc), clothing, and a few others.  I'd try to keep it around five maximum for your own sanity.

Why does a cash budget help?

1.  It creates an emotional tie to your cash, and it's hard to give up the Benjamins!

We have a physical connection to cash that's undeniable.  According to George Lowenstein, a professor of economics and psychology at Carnegie Mellon University, “People experience what my research collaborators and I call a ‘pain of paying’ when they pay for purchases, and this pain is more intense with cash than with cards.  Paying with cards is more carefree.”

I've had many times where my spending decisions have changed once I pulled out the cash.  Do I really need a beer with my meal and that $15 movie from Target, or will it jeopardize my ability to buy food at the end of the month?

2.  When you're out for the month, you're out

Admittedly, we've never starved ourselves if we ran out of money before the end of the month.  However, we're much more careful with our money when we see the envelope dwindling down to nothing.  It's a lot easier to actively manage your money in a cash envelope than 'estimating' how much you've spent by looking at your credit and debit card statements.

3.  You're likely to spend less money when you're paying with cash

It's proven that people spend less when using cash compared to credit cards.  An often quoted study by Dunn and Bradstreet revealed people spent 12-18% less when using cash than when using credit cards.  It all goes back to point #1… it hurts to pay with cash.

The cash budget helped me get out of debt, and it helps us control our spending now.  We aren't as strict on ourselves with it now as I was when paying off debt, but we still use it because it keeps us within normal boundaries and alerts us if a spending category is getting too high.

If you want more information on taking control of your  money and using the cash envelope system check out the "Nurture your money page" on the OWN IT plan.

Have you ever used a cash budget?